'Active Conduct' Rule Removed From Final Cost-Sharing Regs.

The IRS has published final regulations on qualified cost- sharing arrangements (T.D. 8670) that repeal the "active conduct" rule of reg. section 1.482-7(c). The IRS said the change was made to streamline the participation rules; a general rule employing a "reasonable anticipation" of benefits standard was added to the regs.

Proposed regulations (IL-372-88) were issued in January 1992, and final rules (T.D. 8632) were published in December 1995. (For a summary of the final regs, see Tax Notes, Dec. 25, 1995, p. 1592; for text, see 95 TNT 247-4 or H&D, Dec. 20, 1995, p. 4627.) T.D. 8670 makes technical changes to the rules set out in T.D. 8632 for qualification as a "controlled participant" in a cost-sharing arrangement.

The IRS explained that the active conduct rule "was intended to ensure that a controlled participant stands to benefit from the use of covered intangibles in a manner that can be reliably measured." That purpose, the IRS concluded, "can be accomplished without the active conduct rule." It said there is no need for distinctions based on the nature of a participant's use of covered intangibles, "so long as its benefits from such use (whether from directly exploiting the intangibles or from transferring or licensing them to others) can be reliably measured."

In place of the active conduct rule the regs now include a general rule that a controlled taxpayer may be a controlled participant in a cost-sharing arrangement only if it "reasonably anticipates that it will derive benefits from the use of covered intangibles." There are additional rules intended to ensure that benefits to group members are measured consistently.

T.D. 8670 is effective May 13, 1996; the regs are applicable for tax years beginning on or after January 1, 1996.

This document appeared in TNT as 96 TNT 93-8 and in the AccServ & Microfiche as Doc 96-13943 (10 pages).

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[4830-01-u]

DEPARTMENT OF THE TREASURY

26 CFR Part 1

[TD 8670]

RIN 1545-AU20

[1] AGENCY: Internal Revenue Service (IRS), Treasury.

[2] ACTION: Final regulations.

[3] SUMMARY: This document contains final regulations relating to qualified cost sharing arrangements under section 482 of the Internal Revenue Code. These regulations reflect technical changes to the requirements for qualification as a controlled participant under the final cost sharing regulations published in the Federal Register on December 20, 1995.

[4] DATES: These regulations are effective May 13, 1996. These regulations are applicable for taxable years beginning on or after January 1, 1996.

[5] FOR FURTHER INFORMATION CONTACT: Lisa Sams of the Office of Associate Chief Counsel (International), IRS (202) 622-3840 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

BACKGROUND

[6] Section 482 was amended by the Tax Reform Act of 1986, Public Law 99-514, 100 Stat. 2085, 2561, et. seq. (1986-3 C.B. (Vol. 1) 1, 478). On January 30, 1992, a notice of proposed rulemaking concerning the section 482 amendment in the context of cost sharing was published in the Federal Register (INTL- 0372-88, 57 FR 3571).

[7] Written comments were received with respect to the notice of proposed rulemaking, and a public hearing was held on August 31, 1992.

[8] On December 20, 1995, final regulations were published in the Federal Register (INTL-0372-88, 60 FR 65553) as Treasury Decision 8632. These final regulations amend the regulations contained in Treasury Decision 8632 by making technical changes to the requirements for qualification as a controlled participant contained in section 1.482-7(c).

[9] The agency has decided not to issue a second notice of proposed rulemaking with respect to the modifications to TD 8632 contained in these final regulations. The rules to which the modifications relate (concerning qualification as a controlled participant) were the subject of the notice of proposed rulemaking published on January 30, 1992, and comments on those rules were received in connection with those proposed regulations. Therefore, a further comment period on these rules is unnecessary. Taxpayers need prompt guidance on how to conform their arrangements to the rules set forth in TD 8632, which is effective for taxable years beginning on or after January 1, 1996, and which provides a one year transition period for amending arrangements. The modifications contained in these final regulations will aid taxpayers in that regard, and any delay caused by a second notice of proposed rulemaking would be impracticable and contrary to the public interest. Unsolicited comment letters were received in connection with TD 8632 and are available for public inspection in the FOIA reading room.

EXPLANATION OF PROVISIONS

[10] The purpose of these regulations is to rectify problems in qualifying as a controlled participant caused by the technical requirements of the active conduct rule of section 1.482-7(c). This rule provided that a controlled taxpayer may be a controlled participant only if it uses or reasonably expects to use covered intangibles in the active conduct of a trade or business.

[11] Under the 1992 proposed cost sharing regulations, a member of a group of controlled taxpayers could participate in a qualified cost sharing arrangement on behalf of, and could satisfy the active conduct rule based on activities performed by, one or more other members of the group (a cost sharing subgroup). The participating subgroup member would then transfer or license the intangibles developed under the arrangement to the nonparticipating subgroup member(s). The proposed regulations would have measured benefits in such case on the basis of the benefits of the entire subgroup from exploiting the intangibles. TD 8632, in streamlining the participation rules, omitted the subgroup rules. Taxpayers commented that the change would force them to amend existing arrangements to include as a participant every operating company that predictably would be using covered intangibles.

[12] These regulations further streamline the participation rules. The principal reason for the active conduct rule was to ensure that a controlled participant stands to benefit from the use of covered intangibles in a manner that can be reliably measured. The Treasury and Service have concluded that this purpose can be accomplished without the active conduct rule. No distinction need be made based on the nature of a participant's use of covered intangibles, so long as its benefits from such use (whether from directly exploiting the intangibles or from transferring or licensing them to others) can be reliably measured.

[13] Accordingly, these regulations eliminate the active conduct rule of section 1.482-7(c) as a requirement for qualification as a controlled participant in a qualified cost sharing arrangement. Section 1.482-7(c)(1) of these regulations substitutes a general rule that a controlled taxpayer may be a controlled participant in a cost sharing arrangement only if it reasonably anticipates that it will derive benefits from the use of covered intangibles. In addition, section 1.482-7(f)(3)(ii) provides that if a controlled participant transfers covered intangibles to another controlled taxpayer, the participant's benefits will be measured with reference to the transferee's benefits rather than with reference to any consideration paid by the transferee. (This gives rise to results similar to those under the subgroup rules of the proposed regulations by different mechanics.) Finally, section 1.482- 7(f)(3)(ii) continues to provide that the amount of benefits that each of the controlled participants is reasonably anticipated to derive from covered intangibles must be measured on a basis that is consistent for all such participants.

[14] These changes ensure that a controlled participant must benefit from the arrangement, that the basis for measuring benefits must be consistent for all controlled participants, and that, in the event of intragroup transfers, there will be "look through" treatment for reliably measuring benefits. These rules allow a participant to exploit covered intangibles itself or through transferring or licensing them to others, so long as the benefits to be derived can be consistently and reliably measured for all controlled participants.

[15] These regulations also clarify that the documentation requirements of section 1.482-7(j)(2) will satisfy the principal document requirement of section 1.6662- 6(d)(iii)(B) with respect to a qualified cost sharing arrangement.

SPECIAL ANALYSES

[16] It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations, and, therefore, a Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking preceding these regulations was submitted to the Small Business Administration for comment on its impact on small business.

DRAFTING INFORMATION

[17] The principal author of these regulations is Lisa Sams, Office of Associate Chief Counsel (International), IRS. However, other personnel from the IRS and Treasury Department participated in their development.

LIST OF SUBJECTS IN 26 CFR PART 1

[18] Income taxes, Reporting and recordkeeping requirements.

ADOPTION OF AMENDMENTS TO THE REGULATIONS

[19] Accordingly, 26 CFR part 1 is amended as follows:

PART 1 -- INCOME TAXES

Paragraph 1. The authority for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805. * * *

Par. 2. Section 1.482-0 is amended by revising the entries for section 1.482-7(c) and (j) to read as follows:

SECTION 1.482-0 OUTLINE OF REGULATIONS UNDER 482.

* * * * *

SECTION 1.482-7 SHARING OF COSTS.

* * * * *

(c) Participant.

* * * * *

Par. 3. Section 1.482-7 is amended as follows:

a. By revising paragraph (c)(1)(i).

The additions and revisions read as follows:

SECTION 1.482-7 SHARING OF COSTS.

* * * * *

(c) * * * (1) * * *

(i) Reasonably anticipates that it will derive benefits from the use of covered intangibles;

* * * * *

(iv) The following example illustrates paragraph (c)(1)(i) of this section:

EXAMPLE. Foreign Parent (FP) is a foreign corporation

(2) * * *

(ii) EXAMPLE. The following example illustrates this paragraph (c)(2):

EXAMPLE. (i) U.S. Parent (USP), one foreign subsidiary

(ii) R+D does not qualify as a controlled participant

* * * * *

(f) * * *

(3) * * *

(ii) * * * If a controlled participant transfers covered intangibles to another controlled taxpayer, such participant's benefits from the transferred intangibles must be measured by reference to the transferee's benefits, disregarding any consideration paid by the transferee to the controlled participant (such as a royalty pursuant to a license agreement). * * *

(iii) * * *

(E) * * *

EXAMPLE 8. U.S. Parent (USP), Foreign Subsidiary 1 (FS1)

* * * * *

(j) * * *

(2) DOCUMENTATION -- (i) REQUIREMENTS. * * *

(ii) COORDINATION WITH PENALTY REGULATION. The documents described in paragraph (j)(2)(i) of this section will satisfy the principal documents requirement under section 1.6662-6(d)(2)(iii)(B) with respect to a qualified cost sharing arrangement.

* * * * *

Margaret Milner Richardson

Approved: May 2, 1996